What Kind of Commercial Investor Are You? | 4 Types
Residential real estate investors often ask me what they need to know to successfully make the jump into commercial real estate. Do I need to research cap rates? Municipal zoning laws? Commercial property management contracts?
Sure, investors should absolutely learn about all of these items. But, before diving into the details of commercial real estate, I challenge new investors to first consider what type of commercial investor they want to be. This decision serves as the foundation of all future investments, and it allows investors to focus their research into the topics relevant to their future in commercial real estate.
As such, in the following article I’ll outline the four different types of commercial real estate investor. Specifically, I’ll cover each of the following:
● CRE Investor #1: The Developer
● CRE Investor #2: The Commercial Speculator
● CRE Investor #3: The Traditional Investor
● CRE Investor #4: The Owner/Occupant
● Final Thoughts
CRE Investor #1: The Developer
Real estate developers shoulder the most risk of any of the investor types from this article. But, that massive risk also means developers command the largest investment returns.
In a nutshell, developers take a commercial property from initial idea to stabilized property. They are able to look at a parcel of land, envision a future commercial property use for that land, analyze the deal, and actually turn that vision into the reality of a stabilized commercial property.
But, far before actually collecting rents, developers need to invest a large amount of money into initial soft costs, money that will be wasted if the deal doesn’t actually pan out. To receive municipal approval to develop a property, here are a few of the people developers will need to pay:
● Architects
● Engineers
● Environmental consultants
● Real estate attorneys (and potentially zoning-specific ones, as well)
All of these individuals provide necessary inputs to a development plan, and without these inputs, a developer will not be able to receive municipal approval - making the deal dead-on-arrival.
And, these services are not cheap. Developers could realistically pay over $100,000 in soft costs before deal approval, money that will not be recouped if the deal isn’t completed.
However, if you have the stomach to accept these risks, developers also receive the largest returns of any commercial real estate investor type.
Feel free to drop us a note if you need help assembling a top-notch commercial development team in your market. Putting together a great team can seem challenging, and we’re happy to help!
CRE Investor #2: The Commercial Speculator
For commercial real estate speculators, price serves as the most important factor in analyzing a deal. These investors typically work closely with commercial real estate brokers to find properties at defined price points to support their investment model.
Put simply, speculators rely on their experience and efforts to create value in a property faster than passive market growth would provide. Speculators can accomplish this added value by any of the following:
● Increasing rents
● Decreasing expenses
● Remodeling the property
● Undertaking capital improvements
● Improving the quality of tenants
But, ultimately, adding value comes down to increasing a property’s NOI. And, to do this successfully, speculators need to know their markets inside and out. What are the current rents at comparable properties? Cap rates? Vacancy rates?
All of this information will drive a speculator’s underwriting of a particular deal - and dictate the deal’s success or failure. By successfully increasing a property’s NOI, speculators profit both from that income and the forced appreciation it generates.
CRE Investor #3: The Traditional Investor
In the residential real estate world, these investors are often referred to as “buy and hold” investors, as they have a longer-term profit horizon that most other investors.
Traditional investors typically face the lowest barrier to entry in buying their first commercial properties, as they generally pay fair market value for existing commercial properties in an attempt to generate stable, long-term returns on investment. In other words, these investors do not need the experience of developers or the discounted buying opportunities critical to speculators.
From a risk perspective, traditional investors generally do not have the same appetite as either developers or speculators. But, these investors still want A) a reasonable return on their investments, and B) the depreciation-related tax advantages afforded by commercial real estate.
Local commercial real estate professionals can help you identify ideal properties for your market and unique situation - need help finding reliable ones in your area? Drop us a note!
CRE Investor #4: The Owner/Occupant
As the name suggests, owner/occupant investors look to purchase a property that they will occupy with their other business.
For example, a restaurateur paying $7,500/month in rent may choose to purchase a commercial property (likely organized under a separate LLC) that can house the restaurant. That way, instead of paying $7,500 in rent to a separate landlord, the restaurateur uses the restaurant’s rent payments to make his or her own mortgage on the commercial property. This has the following advantages:
● Owner/occupants gain control over rent costs, as they serve as their own landlords.
● The owner/occupant builds his or her wealth via commercial loan amortization (and the associated increase in equity) on the property - in addition to the income generated by the underlying business.
Consequently, owner/occupants are primarily motivated by the property fitting the needs of their own business. Continuing the above example, this restaurateur would be most concerned with finding a commercial space that supported the restaurant’s needs - meaning that owner/occupants will frequently pay more for a property than speculators or traditional investors.
Final Thoughts
At the end of the day, determining what type of commercial investor you want to be will dictate what you need to learn about commercial real estate.
Every commercial real estate investing strategy has its associated pros and cons, and defining your investment type will let you select the best one for your situation - and frame your research into that strategy.
---
We recognize that, even after outlining the above information, tackling the challenges of entering the commercial real estate world can seem daunting.
That’s why we’re here to help. The Pocket Broker team lives and breathes commercial real estate, so drop us a note to see how we can help you achieve your unique objectives!